Commentaries

Core Equity

For the Period Ending: 12/31/2018

Portfolio Manager:
Erik R. Becker, CFA

Market Update

The S&P 500 Index declined 13.5% and the Russell 1000 Index declined 13.8% for the fourth quarter. A sharp risk-off mentality drove negative returns across many asset markets in the U.S. We believe several factors led to the risk reduction. First, evidence of a synchronized global slowdown mounted with weaker economic data in Asia, Europe, and in certain parts of the U.S. economy. Growth momentum weakened in China throughout 2018 following efforts by the government to withdraw liquidity in 2017. Additionally, stepped-up tariffs are beginning to take a toll in China following pre-ordering that artificially held up reported industrial activity. The slowdown can be seen in Chinese auto sales, a great indicator of the health and confidence of the Chinese consumer, which fell 15% during the month of December. European industrial indicators are also weakening on slower global trade and concern around the U.K. exit from the European Union.

Within the U.S., data has weakened with housing starts moving from a 1.3 million pace in the first half of the year to a 1.2 million pace in the fall, as the lagged effects of higher interest rates took hold on consumers. Meanwhile, the ISM Manufacturing Index, a broad measure of industrial activity in the U.S., has fallen from 61.3 in late August to 54.1 in December. The second reason for risk reduction across financial markets has been political, namely the institution of tariffs and the threat of future measures to reduce the size of the U.S. trade deficit. The ongoing trade war has cast a level of uncertainty into markets and led to meaningful declines in corporate confidence. The near-term effect is likely to be felt through slower capital expenditures after strong growth in 2018. A final reason for the fourth quarter sell-off, in our view, stems from the belief that the Federal Reserve (Fed) will raise rates excessively, pushing the U.S. into a recession. The S&P 500 fell nearly 200 points or 8% in value shortly after the Fed’s December 19th decision to increase rates 0.25% and hint that another two rate hikes were on the table for 2019. As 2019 began, the S&P rallied somewhat off fourth quarter lows, partly due to more “dovish” Fed commentary about future interest rate increases.

Portfolio Review

The Ivy Core Equity strategy modestly underperformed both benchmarks. The markets’ worst performing sectors included Energy (-24%), Industrials (-17%), and Information Technology (-17%). The best performing sectors included Utilities (+1%), Real Estate (-4%) and Consumer Staples (-5%). All sectors other than Utilities posted negative returns for the quarter. The underperformance of specific securities in the Industrials sector, combined with a greater-than-market weighting in that underperforming sector, was a significant detracting factor. The strategy’s underweights of Utilities and Real Estate also had a negative effect on relative performance for the quarter. Offsetting these declines was a relatively high level of cash, which averaged above 6% in the quarter.

The current investment strategy is to take a conservative portfolio posture while building positions in companies that have been unduly punished by other market participants.

We firmly believe that during times of market stress, those investors with longer time horizons than a few weeks or a few quarters can take advantage of dislocations in valuations of good companies. For good reason, cyclical names appear the most attractive when considering a 2- or 3-year time horizon. We have selectively increased our weighting in semiconductors with the belief in long-term secular growth and highly defensible business models. We have modestly increased the weighting in Financials to take advantage of the current slowdown in capital market activities that is having a near-term effect but we believe temporary impact on earnings. Finally, we will look toward other hard-hit areas of Industrials, Information Technology, Financials and Energy as opportunities present themselves over the coming months and quarters, always with a longer-term eye on earnings and business model strength.

Outlook

We believe the outlook for the equity market over the next 12 months is highly uncertain given a litany of moving parts that may or may not be resolved favorably. We believe that the most important determinant for the direction of the equity market is ultimately the direction of the global economy. It’s no surprise that the Chinese market (Shanghai Composite) peaked in late January 2018, just one month before the Caixin China Manufacturing PMI (a broad measure of manufacturing activity in China) peaked. Similarly, the September U.S. market peak was followed closely by the first leg down in the U.S. ISM Manufacturing PMI (reported in early October). Conversely, we expect the next major move upward in the equity market will be to discount a bottoming and eventual re-acceleration in economic activity here and abroad. Given emerging markets (namely China) led the current downturn, we would expect that China bottoms before the U.S. China policymakers have taken a “whatever it takes” mantra to stabilizing economic growth, implementing numerous measures (e.g. record consumer tax cuts and reductions in bank reserves) to this end. Clearly, the trade spat with the U.S. is a key unknown variable, though most observers expect some sort of “deal” at the March 1st agreed deadline. With the U.S. a full nine months behind other economies in showing signs of weakness, we believe U.S. data is likely to get somewhat worse before it gets better. To date, housing and industrial activity has shown signs of weakness, while employment and wage trends, consumer confidence, and consumer spending data all remain at or near cycle highs. Some recent data on capital expenditure plans seem to foretell a further deceleration in economic activity. The pickup in capital expenditures along with the Tax Cuts and Jobs Act of 2017, we believe, were the underpinning for the acceleration in economic growth in 2018. Following a strong tax refund season this spring, the favorable tax-related stimulus to U.S. consumers will be largely complete.

The opinions expressed are those of the portfolio manager(s) and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through December 31, 2018 and are subject to change due to market conditions or other factors. Any mention of investment performance refers to gross-of-fees performance, unless otherwise noted.
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Investment Team

Erik R. Becker, CFA

Senior Vice President, Portfolio Manager

Mr. Becker is portfolio manager of the firm’s Core Equity investment strategy and has served in this role since 2006. He has been affiliated with the strategy since 2003 when he assumed assistant portfolio manager responsibilities. He joined the organization in 1999 as an equity investment analyst, covering industries in the consumer discretionary and industrials sectors.

Mr. Becker earned a MS in Finance and a BBA in Finance from the University of Wisconsin-Madison.

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